Friday, November 27, 2009

Is the Dubai Debacle a Game Changer?

Here we see the falling yields on 10-year Treasury notes, as the flight to quality in the wake of Dubai default fears has driven those yields back toward October lows.

The effect of falling interest rates is to reduce the rate of return for investors seeking safe investments, as anyone shopping for certificates of deposit or short-term high quality bonds has realized for a while now.

That, in turn, pushes investors further out on the risk spectrum, seeking longer maturities and riskier asset classes. Hence, the recent outperformance of high yield bonds and both debt and equities among emerging market countries.

Most crucially, falling yields speak more to investor concerns over deflation than inflation. As long as headline inflation cannot provide political cover for the Fed, it is unlikely that there will be a change in monetary policy. That, over time, will support a managed decline in the value of the U.S. dollar, which in turn supports a transition from a consumption-based economy to an export-driven one.

At some point, that weakened dollar will exert inflationary pressures and we will have to reckon with the prospect of higher rates and a changed Fed policy. It's difficult at this moment to see that point on the immediate horizon: all of which will continue to support the dollar carry trade and the flight to risk assets despite stiff risk aversion shakeouts (such as the one we're seeing now) along the way..

About Me

Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), The Daily Trading Coach (Wiley, 2009), and Trading Psychology 2.0 (Wiley, 2015) with an interest in using historical patterns in markets to find a trading edge. As a performance coach for portfolio managers and traders at financial organizations, I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014, along with regular posting to Twitter and StockTwits (@steenbab). I teach brief therapy as Clinical Associate Professor at SUNY Upstate in Syracuse, with a particular emphasis of solution-focused "therapies for the mentally well". Co-editor of The Art and Science of Brief Psychotherapies (American Psychiatric Press, 2012). I don't offer coaching for individual traders, but welcome questions and comments at steenbab at aol dot com.